Why Does Bitcoin Have Value?

On scarcity, trust, and the attempt to preserve purchasing power earned today for tomorrow

You cannot eat Bitcoin. You cannot live in it, and when it gets cold, a bitcoin will not keep you warm. Yet people spend money on it — sometimes quite a lot. What for?

It is a fair question. Anyone who wants to understand Bitcoin should ask it before getting caught up in the next price target. A rising price does not explain value. It initially tells us only that buyers are willing to pay more than they were before.

To get further, we need to consider why we value things at all — and what role money plays in our lives.

Value depends on what we need

Imagine being stranded at an unfamiliar railway station at night with a dead phone. At that moment, a power socket might matter more to you than an expensive painting. The next morning, back at home, you barely give that same socket a thought.

The socket has not changed. Your situation has.

Value depends on what someone can do with something, what alternatives they have, and what they would have to give up for it. That is why two people can value the same object very differently without either of them being wrong.

In the tenth of his 21 Lessons, Gigi describes value as subjective, yet grounded in properties and needs. That is a useful starting point for Bitcoin: we need to understand which of its properties people appreciate and which problems those properties solve for them.

Scarcity alone is not enough

I could write a number on a piece of paper, sign it, and announce that it is the only one of its kind in the world. Its scarcity would be impressive. Demand would probably be modest.

The fact that Bitcoin's total supply is limited to just under 21 million under its current rules therefore does not, by itself, explain a price. A limited supply becomes economically interesting only when people want to own those units.

The order matters: what is something used for? Why do people prefer it to the alternatives? And how easily can its supply expand when demand rises?

Talking only about the 21 million answers the third question. The first two remain open.

What makes Bitcoin useful?

Bitcoin allows people to transfer digital value directly, without a bank having to hold the funds and process the payment. Cryptographic signatures authorize the transfer. Shared rules and verification by the network prevent the same units from being spent more than once.

For someone with a working bank account and a convenient payment card, that distinction may matter little in everyday life. That is understandable. An alternative becomes particularly interesting where the existing solution reaches its limits.

People who want to hold their own funds can control the necessary keys themselves. Someone sending bitcoin to another person in a different country does not need a bank to process that payment. Anyone who wants to check the monetary rules independently can run a full node: a computer running Bitcoin software that independently checks transactions and blocks against those rules.

These possibilities come with conditions. The network must be reachable, transactions incur fees, and managing your own keys requires care. A mistaken transfer usually cannot be reversed. Holding funds on an exchange, meanwhile, creates dependencies on that provider.

There is nevertheless a clear potential use here: some people want to hold and transfer digital value without requiring the permission of an individual financial service provider. That possibility can be worth something to them.

There is also the fact that other people already know and accept Bitcoin. It is possible to design rules for a digital currency with a limited supply. Persuading people to accept it, hold it, and support its infrastructure is considerably harder. The usefulness of the rules is therefore accompanied by the network of people who use them.

Why verifiable scarcity matters

For many goods, a higher price encourages greater production. That can be costly and take a long time, but the prospect of additional revenue provides an incentive.

Under Bitcoin's existing rules, a higher price does not permit arbitrary additional issuance. More computing power does not increase the amount of new bitcoin permitted per block, either. A full node rejects blocks that violate the rules it applies.

Of course, Bitcoin is software, and software can be changed. Anyone can publish a version with different rules. Other participants do not have to adopt those rules, however. Someone who unilaterally raises the supply limit cannot force the resulting additional bitcoin on everyone else.

That makes the limit more than a statement on a website. It can be checked technically and is enforced by participants who use those rules. People who care about a reliably limited money supply may find that useful.

Money connects today with tomorrow

When you earn money and set some of it aside, you move a possible purchase into the future. You could spend something today. Instead, you want it available later: for a repair, a trip, a period without income, or greater freedom in choosing your work.

You have contributed something today and hope to be able to afford something in return tomorrow.

In Bitcoin Is Time, Gigi connects money with time. For everyday life, a simple question follows from that idea: how do we preserve purchasing power between the moment we earn it and the moment we need it?

“Stored lifetime” is a useful image for this. Savings often represent working hours, effort, and wishes put on hold. Money does not preserve those hours directly. It is meant to let us draw on the work of others later.

That is why people take an interest in the rules under which their money is created and how its purchasing power might develop. Bitcoin's predictable issuance and limited total supply appeal to some people who want to save over the long term.

A predictable money supply does not, however, mean predictable purchasing power. What you can get for bitcoin later also depends on how much demand there is for it then. Even if the rules remain unchanged, its purchasing power can fall sharply.

Usefulness and market price are different questions

Two people can know the same facts about Bitcoin and still make different decisions. One values holding their own funds. Another would rather hand over that responsibility. One finds the long-term prospects convincing. Another mainly sees technical risks and uncertain demand.

Such assessments meet in a market. A price emerges where buyers and sellers actually trade. Expectations about the future matter alongside present use. Some buy bitcoin because they want to use it or hold it as savings. Others mainly hope to sell it later at a higher price. These motives often overlap.

Speculation is therefore part of the explanation for price. Expectations can strengthen demand and push the price up. If those expectations are disappointed, the movement can reverse. The technical properties can remain unchanged while their market valuation changes considerably.

The electricity consumed in mining does not guarantee a price, either. Computational work helps protect the transaction history against subsequent changes. The costs involved do not oblige anyone to buy bitcoin at a particular price. Effort alone does not create demand.

Finding Bitcoin useful does not establish that every asking price is reasonable.

What people find valuable about Bitcoin

Bitcoin does not generate business profits, pay dividends in its own right, or give its owner a claim to redemption in gold or euros. Its valuation depends substantially on how useful people believe it is today and will be in the future as money or an asset.

That makes valuation difficult. It also explains why saying “Bitcoin is only digital” misses the point. What matters is what people can do with this digital system and how important that is to them.

Bitcoin has a market value because people are willing to give something in exchange for it. Its limited supply, the possibility of holding it yourself, and transfers without a central processing institution can help explain that willingness. So can expectations of wider future adoption and the prospect of price gains.

An informed assessment therefore needs to consider both the system's properties and its buyers' expectations. The properties explain what Bitcoin makes possible. The expectations help explain the price people pay for it.

What properties do you expect from money? How much control do you want? What do you want to be able to verify? What responsibilities and risks would you take on to preserve purchasing power earned today for tomorrow?

Bitcoin offers an unusual answer. What that answer is worth is for people to decide.

Sources and further reading

• Gigi — 21 Lessons, Lesson 10: Value: thoughts on subjective value, usefulness, and scarcity.
• Gigi — Bitcoin Is Time: money and time, and the ordering of transactions. The connection to personal saving decisions is developed independently here.
• Satoshi Nakamoto — Bitcoin: A Peer-to-Peer Electronic Cash System: direct payments, double-spending, and securing transaction history through proof of work.
• Bitcoin Developer Guide — Block Chain: independent block verification and enforcement of consensus rules.
• Bitcoin.org — Frequently asked questions: limited issuance, usefulness, price formation, and possible losses in value.
• Bitcoin.org — Some things you need to know: price volatility, security, and the limited reversibility of payments.